John Paulson on the Best Investment You Can Make

Too many pundits offer investment tips without any proven success of their own. Hedge fund manager John Paulson isn't one of them. He earned $3.7 billion in 2007, $2.3 billion in 2009, and $5 billion in 2010 -- for himself. He is one of the greats.

Paulson gave his first television interview at the Delivering Alpha conference last week. CNBC aired the interview, which you can watch here. Here are a few things Paulson said about housing that caught my attention.

On housing:

I think we're just at the beginning of the recovery. I expect this recovery to continue for at least the next four, possibly seven, years. It's not too late to get involved. I still feel that buying a home is the best investment any individual can make. Affordability is still at an all-time high. It still costs less to own a home after taxes than it does to rent, and then if you lock in the rates with a fixed-rate mortgage, then you get the benefits of appreciation.

I've offered my own opinion on this. There's no question that homes are cheap in many regions, and screaming buys compared with rents. Just be careful: The most important variable here is the length of time you plan on living in a home. Stocks can be counted on if held for a long time; for short-term trading, not so much. It's similar with homes. Yale economist Robert Shiller put it bluntly: "To me, the idea that buying a home is such a great idea is just wrong. They may very well decline for the next 30 years in real terms."

On what's driving the housing market:

What's driving demand is there's been very little new home construction. There's a shortage of homes to purchase. The inventory of existing homes has come way down, where now it's at a level relative to sales of where it was at the peak of the housing market; there's only about five months of supply. That means in order to meet the demand, we're going to need new home construction. So I think the rate of new home construction will continue to increase, and that's going to benefit the overall economy.

I think this is the single most powerful and overlooked story in the economy right now. Homebuilder CEOs across the board are talking about tight supply and ample building opportunities in recent conference calls. "While production continues to lag the need, we are experiencing supply shortages against a growing demand," said Lennar CEO Stuart Miller. "In most areas of the country, there is a shortage of supply and monthly mortgage payments for a typical home are lower than rent," said Jeffrey Mezger of KB Homes . We'll be hearing about this story for a while.

On mortgage quality:

Once the trends go in a direction, they have a certain force to them. Obviously when [housing] went down, it was a very strong force of liquidation -- banks selling, no financing, prices continuing to go down. Now you've bottomed, and you're going toward the upside. There's a lot of forces that will continue that trend. Banks that make a mortgage loan, that mortgage loan improves in quality as the underlying equity increases. The risk of default, or foreclosure on new mortgages is almost nil. Everyone that bought a home last year with 20% down is, on average, 50% richer today.

The percentage of homeowners under on their mortgages is falling fast, which boosts the quality of mortgage loans. The mortgage market is so heavily associated with negativity that it's hard to think of it as a positive driver, but the trends that clobbered housing-heavy banks like Citigroup and Bank of America are just as powerful today -- in the opposite direction.

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